Under normal conditions, the interest rates that you and I must pay on a home loan, a car loan, our credit card, a business loan are pegged onto two crucial rates. One is the rate that banks charge one another in order to borrow from each other. The other is the Central Bank’s overnight rate. Alas, neither of these interest rates matter during this Crisis. While such ‘official’ rates are tending to zero (as Central Banks try to squeeze the costs of borrowing to nothing), the interest rates people and firms pay are much, much higher and track indices of fear and subjective estimates of the Eurozone’s disintegration.

Following the Crash of 2008, banks stopped lending to each other, fearful that they will never get their money back (as most banks became, in effect, insolvent). Thus, the interest rate at which they lend to one another simply ceased being a meaningful price (just like the prices of CDOs, following Lehman’s collapse, lost their meaning as no one bought or sold those pieces of paper). The truly scandalous aspect of the Libor scandal of recent weeks is that banks continued to use (and ‘fix’) an estimate of the interest rate at which they lent to each other (for the purposes of fixing all other interest rates; e.g. mortgage and credit card rates) when they did not lend to each other any more…

The demise of Libor and other measures of inter-bank lending interest rates left us with the official interest rate of Central Banks, like the European Central Bank. Recently, in an acknowledgment of past errors and of the strength of the European austerity-induced recession, the ECB lowered its key interest rate to 0.75% – the lowest level since the euro’s inception. At the same time, the ECB did something else that is extraordinary by its own standards: it reduced to zero the interest rate it paid private banks for depositing money with the ECB.

Under normal conditions, such an aggressive interest rate reduction would drag downward all interest rates: with private banks being able to borrow at a pitiful 0.75% from the ECB to lend on to the private sector, and having no incentive whatsoever to park their idle capital with the ECB, one might have hoped (as the ECB’s President, Mr Mario Draghi, clearly did) that banks would be more willing to lend and at a lower interest rate. However, such hopes would have been baseless. Indeed, the interest rates p[aid by households and companies remained high, the banks’ funding costs even increased, and the normal ‘monetary transmission mechanism’ (i.e. the system that converts lower official Central Bank interest rates into an increase in the supply of money) proved to be broken and beyond repair. The question is: Why?

Here is the answer, as provided by Christian Noyer, a governor of the Central Bank of France (in an interview with Handelsblatt): “We are currently observing a failure of the transmission mechanism of monetary policy. From the markets’ perspective, the interest rate facing individual private banks depends on the funding costs of the state where they are domiciled and not on the ECB overnight interest rate… Hence the monetary policy transmission mechanism does not work.”

Now, this is an admission that should be on every headline in Europe, given that it comes from a governor of the Central Bank of the Eurozone’s second largest economy. It is equivalent to a pilot picking up the intercom and saying to the passengers: “The landing gear has failed.” And as if this were not enough, Mr Noyer added for good measure: “We did our best to face up to this phenomenon which is unacceptable for a Central Bank in a monetary union.” What did he mean by that? The clue comes from his follow up sentence: “In future we cannot rely endlessly on a system where the Central Bank is injecting massive liquidity to the banking system, boosting hugely its balance sheet.” Clearly, Mr Noyer was referring to the LTRO; the ECB’s attempt earlier in the year to ‘fix’ the ‘transmission mechanism’ by pumping 1 trillion euros of liquidity into the Eurozone’s banks. Reading between the lines, it is clear that, at least according to Noyer, this ploy failed (as some of us kept saying it would).

In summary, borrowing costs in the Eurozone have lost their two anchors: the inter-bank lending rate (courtesy of the sad reality that the banks no longer lend one another) and the overnight ECB interest rate (which banks ignore when lending). The key to understanding this breakdown is governor Noyer’s phrase “the interest rate facing individual private banks depends on the funding costs of the state where they are domiciled and not on the ECB overnight interest rate”. In short, the fear of a disintegration of the Eurozone (that is aided and abetted by silly talk of Greece’s and Portugal’s expulsion) has broken the umbilical cord that normally connects the ECB’s overnight rate with actual borrowing costs of the private sector. Now, the later reflect the fear that the member-state in which the firm or the household are will not be able to refinance itself. In a never-ending circle this fear ensures that the said member-state will not be able to refinance itself and, crucially, guarantees the ECB’s failure to lower interest rates even when it pushes its official rates to zero. This is what a monetary union on the verge of collapse looks like.

82 Comments

It’s time to end up with banks and move towards a digital money based economy, where money circulation speed will be adjusted by software acting based on predefined rules.
In such an economy interest is not the only tool to adjust and demurrage can also be one of the tools.
In such an economy you cannot have toxic derivatives bubbles sucking up real, productive economy.
Your experience in Valve will give to you a lot of food for your thoughts on the matter. 😉

@Baboulas
Rules are the laws coded in to software and executed by computers.
Computers don’t break the rules.
Humans do!
@Gray
Second life is a good example for the concept ad also a bad example to avoid in various aspects of their economy.
It was a good start though

Thanks Yanis, a good piece! I would like to add a comment to Noyer’s remark “From the markets’ perspective, the interest rate facing individual private banks depends on the funding costs of the state where they are domiciled and not on the ECB overnight interest rate…”

This is just part of the truth. These interest rates depends also on the TBTF or not status of the bank in question.

According to a recent study by Kenichi Ueda and Beatrice Weder di Mauro for the IMF, the implicit guarantee to keep such banks alive, no matter what it costs the taxpayers, is making the difference of 4…5 notches in the ratings (for instance the difference between A+ and BBB-). Which in turn means 0.6 to 0.8 lower refinancing costs.

So, for JP Morgan, this implicit guarantee amounts to 14 billion USD per year, for all TBTF US banks to 76 billion USD – their whole profit in one year.

Do they let participate the taxpayers on these windfall profits? No, of course not. Only losses are being socialized in this perverted anglo-saxon sort of capitalism. This is what I complain about since years, why I say that TBTF banks must be annihilated, Glass-Steagal must be re-introduced worldwiede, and failed banks must die, fast. Not keep them with taxpayers mone in a zombie-life state.

You must be clearly out of your mind. We are not talking about banks buying country bonds which I agree their rates should reflect each country’s fiscal situation. Banks are borrowing money from the ECB for 0,75% and are lending it to businesses and individuals at rates up to 10% or more in the cases of the “club med” as you say. That is in the very few cases they actually create new loans since their basic operation nowadays is the rollover of outstanding loans. When a bank lends money to a business it is the fundamentals that need to be checked not where its basis of operations is. Perfectly healthy businesses are being forced to borrow money at non-sustainable rates even though the ECB rates are so low. This is an absurd situation. All the club med countries are slowly driven towards illiquidity.

Right, Pedro, I agree, this is what I argued since years: there were de facto eurobonds between 2001 and 2008, the spread of ClubMed bonds over Bunds was permanently at or below 0,25%.

But I doubt that the ClubMed agrees, because it’s business model was solely based on an inflow of cheap loands. This can’t be sustainable, of course. Not for the lenders and not for the debtors, as both learn the hard way at the moment.

BTW, today Greece asked for a bridge loan to pay back some 3 billion in a few weeks. Plus, of course, there is the demand to prolongue the timeframe for restructuring by at least two years. Which means, of course: kicking the can down the road again, and end up with even higher losses.

Ah, have you heard about the isle Ikaria? it is linked to Greece by a contract, which runs out this week. The people there want to switch from Greece to Austria. We’ll see if Greece respects the free will of the Ikarians.

@VSS
The island of Ikaria is part of Greece right in the middle of the Aegean Sea. Anyone can pick the contract to link the island by sea to Piraeus, provided it enters the contest and meets the specifications. I do not know of any Austrian shipping companies so my guess is that the story is bogus unless it refers to airport connection but the same rules apply.
You are correct about the mistake of pricing country bonds as de facto eurobonds but it is an equal mistake to misprice loans to the private sector due to sovereign bond differences. It does not make sense for two perfectly healthy companies that operate in the same markets in the eurozone as well as their domestic ones and have completely different access to money due to their respective country ratings. If that is the case from now on then each country should revert to their own currencies to offset this extraordinary disadvantage by devaluation and access to reasonably priced money.

Tasos, before the Euro was announced Club Med businesses also paid higher interest than GErman businesses. At that time the market was intact. So everything else is a distortion. And distortions lead to problems.

@Pedro
Trust me they did not paid the rates that are being asked today. Not by a longshot. Today even access to new money is impossible. Also in a single open money market like the eurozone, companies should be rated individually and based on their fundamentals. A company for example with good cash flow, low debt and diversified market shares in the common eurozone market should get a good rating and good money rates regardless its base of operations. This does not happen because of “country risk”. Well this is not working so either something must happen and healthy companies can find access to moneymarkets again or we should be done with the eurozone alltogether. This split between absolute winners and absolute losers is the end.

Hehe.
If you really know how to read this chart ,then thinking about the basics ,you should wonder why Germany allowes the imbalances to continue after the Lehman collapse which has nothing to do with Greece or any other country.

Do you know why all these lines are together? Because you can not take anything into isolation. Germany having lower spreads is worse than Greece having higher because Germany allowes the imbalances.
Why? To get property. That is why.

So no looky-looky and no Lucky Luke because your governments’ shadow is about to kick your butt.

@Pedro
You posted the 10yr rates of SOVEREIGN bonds..I am speaking about the PRIVATE sector loan rates. You do not seem to understand the difference and its consequences to an economy. Check a textbook. You might learn the relation between central bank rates, comercial bank rates, inflation…so on..the chart you posted basicaly implies the euro is over. Not only for Greece, for everyone.

I have to repeat myself: Before the Euro was announced the Club Med paid higher interest than Germany/Austria etc. At that time the market was intact. So everything else is a distortion. And distortions lead to problems.

@Tasos. I knpow that this is a chart for sovereign debt. I doubt there is a chart for private debt. I also doubt that rates for private debt typically is lower than the rates for sovereign debt of the same country. At least in the AAA countries where I have lived it is not the case.

LIBOR Ain’t Nothing But an Acronym: We Must Abolish the Finance Capitalist Class

“The system itself is a criminal enterprise that preys on the entire planet.”

The latest finance scandal concerns the LIBOR, the acronym for the interest rates banks offer each other for loans. Because the LIBOR rate is used as the basis for so many other financial calculations, some people say the scandal is potentially the biggest in the world. And then, there are those of us who wonder if the LIBOR case, in and of itself, really matters at all.

It is almost as if a bank has just been robbed, and the customers are all worried about the way that the robbers are calculating the value of the loot.

The fact of the matter is, the robbery was an inside job. In this case, it appears that virtually all the big bankers and the people who were supposed to be regulating them were in on the crime – although, so far, only Barclays Bank in Britain has been fined. The banking system was not victimized by some shadowy group of predators who could be quarantined – after which all would be well.

No, the system itself is a criminal enterprise that preys on the entire planet. What we have observed, most dramatically since the meltdown of 2008, is that the banksters who run the global financial criminal enterprise also control the political mechanisms of the western world. The state and, ultimately, the people pay the cost of the bankers’ crimes. Not only are the criminals not punished, they are rewarded with trillions of dollars in virtually free money from world’s central banks, including the U.S. Federal Reserve. This allows them to grow even bigger, and to commit ever larger criminal transactions, which the banks ultimately record as profits or pass on as losses to the public at-large.

“It appears that virtually all the big bankers and the people who were supposed to be regulating them were in on the crime.”

Mathematically speaking, the biggest impact of LIBOR rate-fixing occurs in the world of derivatives, a universe inhabited solely by finance capitalists. The realm of derivatives dwarfs the one in which the rest of humanity lives:

There are, perhaps, $1,000 trillion in derivatives hovering over a real world economy that is valued at only $70 to $80 trillion a year. That means the derivatives economy that is the playground of Wall Street is 12 and-a-half to 14 times bigger, on paper, than the real economy.

Put another way, the bankers routinely place bets that are bigger than the real world’s actual worth – much, much bigger than the value of all the goods and services produced by every man, woman and child on the planet. Clearly, the derivatives trade is a bomb – a world-threatening monstrosity – that must be dismantled.

The public’s interest is not in how phony LIBOR rates affect the prices of a thousand trillion dollars in derivatives. Rather, humanity desperately needs to abolish the derivative trade, altogether, before it crushes the real economy.

To abolish derivatives, we will have to put the banking class out of business.

Noted economist Nouriel Roubini says some of the bankers ought to be hanged in the streets, to teach them a lesson. What’s certain is, if you don’t hang them, they will use their control of the government to hang thousands of you.

Forget LIBOR. It’s just a gauge on the console of the bankers’ crime machine. The criminal class, itself, must be eliminated from public life.

And there floats the theory that ECB lending or deposit rates refer to banks’ reserves. Reserves are, by regulation, connected with deposits not loans, so, in fact there is no a priori connection with loans or credit.

Given that the reserve maintenance period requirements corresponds to (deductible) 10 trilion 1O ^12 euros and presents a surplus, one can ask? Why the LTROs?

@Gray goods
You have a very interesting attitude. I guess Dimitri is trying to say that the blame of the mess can be put also on Germany (and the other countries as well) and not only on Greece.
It seems to me that Germany is sick of bailing out the other countries it could leave Euro too. And in the long term of course this will hurt German economy as well, I understand their complaints, nonetheless they are still in. Don’t you suspect that it’s harder than you think to leave. And do you really think that if Greece leaves the Euro zone it won’t have political and economic consequences on the other countries?

Troika does not want us out of the euro ,that is why it terrorised the ignorant people in voting their partners in crime again and noone in here thinks you can bail us out. The opposite. You can not. And your government will destroy you too.

But as long as you earn more by exports and hold this system a little bit longer ,you like to hurt others.
Because money matters more. And this will be your doom.

For those who wonder why we are attacking Germany and go as far as to say about them trying to enslave Europe. For those that try to understand the behaviour of the “leaders”. For those that try to uinderstand why “Justice” does not seem to do her job. For those that now say it is France’s fault and have the habit of finding scapegoats. Dig deeper than that.

Here is a full analysis of how certain someones used the behaviour of Germany for their own interests and how they now use her against the whole continent. The citizens of Germany would do well to open their eyes soon because their country is about to be humiliated again. Arrogance and the self-denial of the existence of criminals like Schauble ,who answer to other masters ,will have the German citizens be ashamed again.
WAKE UP.
They are not even a country anymore. Not even a protectorate. Only a small company owned by some.

If the ECB lending rate in ineffectual, why is it being kept so low? My suspicion is because the only thing keeping up the appearance that the banks are solvent is a massive carry trade enabled by the mythical ECB rate and the actual national bond rates. If that spread disappeared, bankruptcy couldn’t be forestalled any longer. Or am I on the wrong track?

So ,once again you say that we tiny Greece are responsible for the multi trillion problems of Europe and that we are pathetic. Not at all pathetic by your side.

Well Martin ,i just understood something that exonerates that Stalinic Merkel and that Nazi “economic war general” Schauble.

They really are trying to help us. Thank you Germans and blind citizens of Germany.

When we Greeks die ,we must pay gold coins to the boatman ,to cross us over.
Recently Hades decided to sent back to life people that can not cross over.
Well ,there you have it. They are bankrupting us ,because they want us immortal.

Dear Demetri
I never said (and don’t believe) that Greece is responsible for the “multi-trillion problems of Europe”.

How would a single, relatively small country be responsible for all of that??

But it is responsible for the mess it got itself in. Which is of course a lot smaller than the problems of the world as a whole. 😉

…But Greece’s share in the problem is remarkably high, given it’s size and economy.

Nobody “wants” to bankrupt you (except for maybe some finance idiots that bet on it with CDS etc). You’ve bankrupted yourself by accumulating up a huge pile of debt without building an economy to support it.
…and then handling the following emergency in the way you’ve done: Pretty pathetically.

This does not mean that all Greek are pathetic. I am talking about your political and economical class / elite.

Ok ,i accept it to a point.
What you seem to miss out is that ,that pathetic behaviour is not only Greek. It is not Greek elite. It is just an elite (of any nationality) that attacks a country after an artificial debt increase that has no relation to the true economy of Greece. Just days ago a prosecutor got evidence of manipulation of data so that Italy and Greece appear worse than they are.

This is the biggest disadvantage of the attackers. They attacked in such an arrogant way that at the end they revealed their true plans.

Again ,basic economics. There is no true economic problem. There never was any. Only manipulation of the flow.

You have to know who your leaders are and with whom they do business in Greece and other countries.
The justice system is rotten and the most rotten system is Germany’s. They imprison common criminals ,but the only give a sentence of 24 months to social criminals because this is the limit for someone not to go to prison while the German justice appears to have done something honourable. Then they use them by putting them in high places ,as long as they serve the interests of Germany ,which interests in reality are not even Germany’s. You are the primary slaves because they use your own character against you and against the entire continent. The fact that you want to appear better than the rest.

Now our justice system is infected by the children of the traitors of Greece in the WWII ,like Pikramenos ,the PM of the transitional government ,who is of Germanic culture.

Sorry ,man ,but any historian who wants the truth knows that the Nazis never left. They are there with you ,maybe a neighbour of yours ,hidden in plain sight because of your protestant habits ,and the only reason Germany succeeded ,is not because of your hard work as you want to think, but because someone wants to control the most naive slaves of humanity to attack the rest of Europe. Again.

Troika lets everyone go free that help its interests. The Greek government didn’t do anything else than what it was ordered and the Greek population will have to fight off these criminals again without the support of other nations because you are all too stupid to understand. AGAIN.

Dear Demetri
I think you are too much into conspiracy theories. There are differences between cultures and nations – they have different preferences and values. Up to a point, that is fine. It’s what makes Europe such a diverse, fascinating part of the world.

So, by the way, if Greece wants to not take part in the rat race and take it a little easier, I think that is Greece’s right. It would then long-term have a lower income per head than other comparable countries that work harder. But in my eyes, that is a choice Greece of course has. The problem was that the system that collapsed 2009 in Greece wanted to carry on in a “relaxed” / inefficient etc way while at the same time promising the population a living standard close to that of Switzerland.
This cannot work and got you into debt.

I don’t really believe there are still loads of Nazis in Germany. The original ones are mostly dead now. Everybody who was not a little child when the war ended is not in his or her 80ies.

Of course, if you consider being protestant / working a lot, etc “Nazi” then that’s a different story. But that is not what “Nazi” really means.

I think you are imagining something when you think that “Germany” is trying to take over the world / the EU / southern Europe or whatever.
Why would it do that? How would it do that? The mood in the population is against it.
Plus, there is NATO and the EU so even if the leadership had some evil, secret plan, it would be very difficult to implement it.
Germany just wants to live in peace, preferebly within the EU, not dominating anybody. But not having to finance millions of people either. It should be a “win-win” situation. Like it was, basically before everything started to go wrong with the introduction of the EURO.

Well Martin you still continue using the propaganda about Greeks wanting to have it easy and you have no idea what happens in Greece.

Now ,i didn’t say that Germany wants to dominate (only) ,i said that Germany is the primary slave thinking that it can succeed because of the arrogance of people like Schauble that freed Hepfer and his son after German athletes had sued Hepfer (the father) for experiments.
Hepfer the son works in the justice field now (if i remember correctly).
And more.

I say that while Holland arrested more than 30000 Nazi partners ,Germany arrested 20. Only 10 went to prison. They say they all moved to Latin America ,only that there never was a mass collonisation-like movement. They suddenly vanished.
And more.

Then we have the German justice system that frees all social criminals that bring money to Germany.
And more.

I do not say that Protestants are Nazi. Far from it. I say that in this double layer society ,because you do not know your neighbour ,everyone can hide in plain sight ,as our own Christoforakos does. The son of another Greek traitor that works with your government.

No ,sir ,these people are not gone. They are here and well. Amongst you.

I am glad you think I do understand Germany. That’s at least something – and certainly the area where I feel more I have a realistic chance of kind of understanding what’s going on.

With Greece you may be right – no idea if I understand. I am not sure anybody really does (including the Greek). It’s a country in a major crisis. Brings out the best and the worst in people – unfortunately tends to be more of the latter.

I think the mistake you are making is putting the Greek government and the Greek people into the same basket which says “Greece” on the outside.

If we can break our references into the “Greek people/taxpayer” and the “Greek government” instead of referring to both as simply “Greece” it is makes commentary about the Greek governments crisis accurate.

Greeks hate bailing out the Greek government as much as people in Germany.

It is not “now” that the “monetary transmission system is broken”; it was never there, in the first place. And it is not just “in the Eurozone” that it does not exist; it is non-existent – period.

What the Eurozone monetary transmission debacle shows (along with the respective debacle across the Atlantic, where Bernanke & Co, are equally busy at the Fed pump) is that the money multiplier is a myth: Banks will only lend when there are creditworthy customers out there and the economy is relatively promising.

Central banks, whether federal or national, may pump money into the banking system reserves until the coffers overflow (to conjure a Scrooge McDuck image) but the banks will sit on those reserves until the cows come home – or, alternatively, the economy improves.

With the private sector in the periphery, and soon in the epicentre, in such a disarray, the situation trivially requires a (massive) fiscal intervention. This, however, is impossible for any one Eurozone country entangled in this mess, because of being non-sovereign in its currency and being restricted by Maastricht.

Slade had a hit in the 1970s that went something like “Hey, mama / We’re all crazy now”. I expect a reunion.

Dear Yanis,
If i have understood correctly, you say that the monetary authority (i.e. the EcB, with a small “c”) of the European monetary union, has left itself incompetent, with no real, actual or official, role! Is that correct?

Yanis – Great find on the comments from Noyer! Without growth, efforts to reduce sovereign debt will only slow the rise, not reverse the trend. Since the transmission mechanism for monetary policy has failed, fiscal policy remains the only real option. Sadly, fiscal policy is generally moving in the wrong direction and a fiscal union remains a distant dream. My outlook is similar to yours, the monetary union is nearing its end (http://bit.ly/Q5HgNk).

Good reading. Given that the ongoing crisis has always been in part a financial crisis, it is no surprise that (extraordinary) monetary policy does not produce the desired effects. What we have witnessed in the course of this crisis, is that the ECB may only obfuscate the fact that an existential crisis has gripped the euro, by means of extra liquidity, which can only buy some additional time in the short-term. The point is that for as long as there is no determined response from EU leaders to stick by the euro, there is little the ECB can do on its own accord.

As for interest rates, we must also bear in mind that they are at exorbitantly high levels for the individuals, because banks prefer the safer alternative of channeling any extra funds they have to perceived safe havens, i.e. core eurozone government bonds (e.g. German). Let alone the fact that “top quality” bonds are considered good collateral for the stress tests for capital adequacy they are now conducting…

With the confidence crisis in place, any monetary measure may only strengthen the downward pressure on the rates of core Eurozone economies, as banks will continue to rash to the perceived safe havens. This is a regime for further disintegration as the core countries have even less pressure to carry on with system-wide measures (why should they if they borrow at negative rates?), while the periphery continues to suffer from a dearth of liquidity which destroys the real economy.

A solution, if possible after all, will come from audacious political decisions (an implementation of the Modest Proposal perhaps), not from the ECB/Eurosystem…

Protesilaos You obviously didn’t see the contradiction when you wrote your comment.

Your saying that the ECB pumping liquidity into markets is hurting the real economy with higher interest rates.

And yet at the same time you are saying we need a concerted effort by politicians to stand by the Euro (I assume you mean more spending). Given that debt is already at unsustainable levels what do you propose they do?

In lack of the ability of printing sovereign money, a eurozone-wide public bank would really be able to implement the, so called, transmission mechanism. The question, of course, is raised: how would such an institution be correctly managed. It seems to be that both a hierarchical structure and a multidisciplinary inflation target should be enforced to this bank. The central bank could set the average interest rate target and domestic policies could set the rates in different credit disciplines, together forming a hierarchical structure. Possibly, the parts of such a bank in each eurozone country should not be allowed to buy domestic government bonds, and could have collectively defined (by eurogroup) limits and distributions for external EZ bonds…

28 Trackbacks

US

Thank you for visiting my blog. As you have just clicked on ABOUT, I take the liberty of assuming that a tale on how this blog came into being, as well as a few intimate details on its author, may be in order